Just nine days ago, I opined that it was reasonable to expect that the largest marijuana producer in the world, Aurora Cannabis (NYSE:ACB), might fall below $4 a share – a price point that seemed unimaginable with the company's stock lapping at $10 just six months prior. But in just over a week's time, Aurora is dangerously close to proving this $4 prognostication accurate.
Unfortunately, $4 may not be a bottom for Aurora Cannabis. Despite what looks to be an incredible value, when taking into account its international reach and peak production, a perfect storm could wind up sending the most popular pot stock with millennials below $3 per share.
Admittedly, a lot would have to go wrong for Aurora to see a $2 and change share price, but the triggers are in place for it to happen. Here's what Aurora's 'perfect storm' would look like.
Supply issues extend further than anyone could have predicted
The 800-pound elephant in the room for Canadian marijuana growers has been the persistent shortage of pot products since day one of recreational legalization in Oct. 2018.
Part of this shortage can very well be blamed on the growers themselves, many of which waited until it was a veritable certainty that the Cannabis Act would be signed into law before shelling out big bucks to expand and acquire capacity. This has left most growers scrambling to complete production facilities nearly a year after the green flag waved on adult-use sales.
However, the bulk of supply issues to our north are the result of Health Canada being bogged down by cultivation, processing, and license applications. Even with procedural fixes in the works, this backlog isn't going to be resolved overnight, or possibly anytime soon. Couple this backlog with the snail's pace by which some provinces have been approving physical dispensary licenses, and you have a recipe for ongoing supply shortages that could last into perhaps 2021.
Mind you, it's not just dried cannabis that could be impacted. Derivatives, such as edibles, infused beverages, topicals, concentrates, and vapes, are set to launch by mid-December. These products are liable to face the same adversity that dried flower has been facing for nearly a year.
International sales are stymied
There's no denying that Aurora Cannabis has an impressive international presence. Only three marijuana stocks have access to at least a dozen foreign countries from a production, export, partnership, or research perspective, but Aurora leads that list. These external sales channels should prove especially important if and when oversupply and commoditization of dried flower becomes a problem in Canada.
The concern is that Canadian growers are unlikely to push into international markets until domestic demand has been satisfied. And, as noted, it could be numerous quarters, if not years, before supply issues in Canada have been resolved sufficiently to ensure that domestic demand is being met. Aurora has hinged its future on overseas markets; however, these markets are unlikely to deliver much in the way of returns for perhaps two or more years.
Aurora takes a substantial goodwill writedown
Maybe the most direct threat to Aurora's valuation is its gruesome balance sheet, which is currently lugging around 3.17 billion Canadian dollars in goodwill. Goodwill being the "premium" that an acquiring company pays above and beyond tangible assets for the company it purchases.
While it's not terribly uncommon for goodwill to be recorded when one company buys another, Aurora's is out of control. Over the past three years, the company has made well over a dozen acquisitions, with anywhere from 50% to 80% of the value of these deals often being recorded as goodwill. The hope is that Aurora will develop the assets of the businesses it's acquired, as well as monetize any patents, and recoup the value of this goodwill. But lugging around CA$3.17 billion in goodwill is going to be difficult to recoup.
What's more, CA$3.17 billion in goodwill represents 58% of the company's total assets. Sure, Aurora might look dirt cheap at less than 1.3 times its book value, but understand that CA$3.17 billion is goodwill and another CA$688 million is intangible assets. That's CA$3.86 billion of CA$5.5 billion in total assets that's built on hope rather than fact. If Aurora takes a sizable writedown, its share price could tank.
The company dilutes shareholders even more
Aurora's acquisition spree has also led to an ongoing problem with share-based dilution. The company has financed practically every acquisition entirely by issuing its own stock as capital, thereby ballooning its outstanding share count and diluting the value of existing shares. Between June 2014 and June 2019, Aurora's outstanding share count rose by 1 billion. Yes, billion.
Making matters worse, the company has a CA$230 million convertible note offering that comes due in March 2020. As my colleague Keith Speights notes, the conversion price is nowhere near where Aurora is currently trading, meaning no debtholder in their right mind is going to opt for the conversion. That means Aurora Cannabis is going to need to come up with CA$230 million to pay off its noteholders in less than six months' time.
How will it do this? Despite having some cash on hand, the logical answer is to again issue more stock, or possibly offer new convertible notes that could be converted into stock at a later date. No matter what actions Aurora takes, it typically results in shareholders getting the short end of the stick.
The U.S. remains an illicit market at the federal level
Lastly, there's built-up hope among investors that Canadian growers like Aurora Cannabis are going to benefit from a softening of the U.S. federal government's stance on marijuana. It's currently a Schedule I drug in the U.S., meaning it's entirely illegal, prone to abuse, and has no recognized medical benefits. Any sort of reform would be viewed as a major positive for the global pot industry.
However, it's looking unlikely that we'll see any sort of serious progress made before 2021, at the earliest. Even the recent passage of the Secure and Fair Enforcement (SAFE) Banking Act should be taken with a grain of salt given the likelihood that it'll stall in the Republican-led Senate. Pretty much all cannabis legislation is dead as long as Mitch McConnell (R-Ky.) remains Senate Majority Leader.
With the U.S. marijuana market pretty much off the table for Aurora, and the potential for a goodwill writedown exceptionally high, the perfect storm may be brewing that could push this popular pot stock below $3 a share.